Highlights:

• The private equity business it has recovered to a constant level.  In 2012, private equity transactions related to Germany reached a total volume of approx. EUR 5.8B. Other than in the United States, volumes and conditions have not returned to their levels of before 2007, but there is development in this direction.
• Following 2007, leverage decreased significantly and most recently settled between 50% and a maximum of 70%. At present, a return to pre-2007 leverage ratios is not to be expected in the short term, also in view of the increasing capital requirements for banks. Leveraging transactions by a combination of bank financing and (in some cases, structurally junior) bond financing via the capital market is clearly on the rise.
• The current uncertainties in the debt and [capital/equity] markets and the resulting requirement of being able to react to changes on short notice are often reflected in flexible sales schemes or exit strategies
• Multiple-track processes are currently standard practice, especially in larger transactions, and are also used outside the private equity business by industrial companies in carving-out  or selling sub-groups.
• Deals are increasingly structured to include management participation in the profit or losses

Main Article:

Multi-track transactions, club deals and direct investments by pension funds: currently wide-spread development in transactions.

Börsen-Zeitung, 15 June 2013

Although the private equity business in Germany has yet to reach pre-Lehman Brothers volumes again, it has recovered to a constant level. In 2012, private equity transactions related to Germany reached a total volume of approx. EUR 5.8 billion according to the industry association BVK. Other than in the United States, volumes and conditions have not returned to their levels of before 2007, but there is development in this direction. The trend has been confirmed within the first five months of the current year, when CVC funds bought Ista in the first billion-volume deal.

It’s all about the right mix

If one takes a closer look at the M&A transactions with a private equity component, however, it becomes evident that there are major differences as compared to the years until 2007.

Leverage. Until 2007, the share of non-equity financing (leverage) was as high as 90%. In the years that followed, this share decreased significantly and most recently settled between 50% and a maximum of 70%. The decline is not surprising, given the consequences that the financial crisis had also for the banking system. At present, a return to pre-2007 ratios is not to be expected in the short term, also in view of the increasing capital requirements for banks. Against this background – and also in view of the trend towards corporate bonds – leveraging transactions by a combination of bank financing and (in some cases, structurally junior) bond financing via the capital market is clearly on the rise. A current example is the bond financing in connection with the Ista transaction.

Multiple-track transactions. The current uncertainties in the debt and [capital/equity] markets and the resulting requirement of being able to react to changes on short notice are often reflected in flexible sales schemes or exit strategies. This is especially the case where the sell side also involves a private equity firm (secondary or tertiary transactions).

Including recapitalisation

The sale of Kabel BW by EQT to Liberty in 2011, which served as a role model for other transactions, is a prominent example. In parallel to the auction process, the former owners – funds advised by EQT –prepared for an IPO as well as for a refinancing through the placement of a bond on the capital market. By simultaneously preparing multiple alternatives for a partial or complete exit from the investment, they intended to achieve the highest degree of transaction security that was possible in those uncertain times. In the end, the deal comprised a sale to a strategic bidder (Liberty) and the placement of a bond in the period between signing and closing of the transaction, allowing for part of the proceeds to be distributed prior to the closing date by way of recapitalisation.

Multiple-track processes are currently standard practice, especially in larger transactions, and are also used outside the private equity business by industrial companies in carving-out  or selling sub-groups (such as the spin-off of Osram from Siemens or ThyssenKrupp’s sale of its stainless steel business in 2012). Due to their high complexity, multiple-track transactions make very high demands.

Management rollover. One of the material success factors of private equity is the participation of the management and of key employees in the company with the aim of synchronizing their interests and the Company’s interests to the highest degree possible. In most cases, the participation is structured in such a way that if the company’s development is normal or negative, management participates less, and if the targets are overachieved, management participates more.

New challenges arise due to the increase in transactions in which private equity funds are involved both on the seller’s and on the purchaser’s side. Upon initial participation in the target company, management is often in an inferior economic position due to the limited funds it can invest and frequently needs financial support (such as a loan) to fund the participation. Accordingly, their position when it came to negotiating the conditions of the management participation programme has been weak.

The past years, however, have shown that the balance of power can shift quickly, at the latest after the first successful exit in which management participated to a large degree in the resulting profit. If the sold company is again acquired by a private equity company, the latter is then dealing with a party that is considerably more self-confident when negotiating th next management participation in the target company. Management then – at least partly – sees itself more as a co-investor. From a legal perspective, the transfer of the existing participation to the transferee is a particular challenge, if the parties seek to avoid unnecessary back and forth payments.

Club deals. In particular in transactions involving infrastructure entities (airports, power grids, gas grids etc.), the number of club deals, i.e., transactions involving a consortium of bidders, has lately increased. Current examples are the acquisition of Open Grid Europe by a consortium consisting of Macquarie, Adia, Meag and BCIMC as well as the acquisition of Net4Gas by Allianz Capital Partners and Borealis Infrastructure (a subsidiary of the Canadian Omers pension fund).

But also in traditional private equity transactions, bidders have teamed up on numerous occasions, for example the mid cap funds Bregal and Quadriga for the acquisition of LR Health, or Aea Investors and the Teachers Private Capital pension fund for the acquisition of Dematic.

Besides risk sharing considerations and the increase of the potential transaction volume, regulatory requirements play a role. The acquisition of a majority holding, for example, would regularly not be permitted for pension funds, or would not be desirable, for example for insurance companies or banks, for consolidation or capitalisation aspects.

Club deals do not show any special characteristics on the sell side, as the parties involved normally pool their assets to form an acquisition vehicle; at most, the procedure for obtaining the necessary antitrust clearance may become more complicated due to the larger number of parties involved. On the bidder side, however, the transaction will definitely be more complex, as, in addition to the acquisition documentation, a consortium agreement is needed. In such agreement, in addition to provisions governing capitalisation, the rules on corporate governance and a later exit must be stipulated. In this context, problems may arise in particular where different investment horizons are involved.

Direct investments. The trend towards mega funds and the significant management fees associated therewith have led some investors to consider engaging in the private equity business themselves. This is especially true for the major Canadian pension funds, which play a trendsetting role in this regard (e.g. Ontario Teachers, Canada Pension Plan or Omers) and which have established their own private equity departments or subsidiaries. These pension funds usually refrain from taking the lead in the acquisition of companies, mainly due to regulatory constraints, but direct investments are on the upswing.

A firm position

These are direct participations in the (topmost) holding company through which the target company is acquired. In the past, the typical clients of private equity funds were pension funds that invested in them and thus participated in the fund’s total return only. Direct investments allow for a more targeted risk allocation when investing, and also give the private equity company greater flexibility in structuring its fees.

It becomes clear that private equity continues to hold a firm position in the German M&A market. In the long-run, only those equity investors will remain successful that are able to react flexibly and quickly to changes in the markets will remain successful. And, the market leaves room for dynamics.